Barclays Capital warns in the 56th edition of its
annual research publication, the Barclays Equity Gilt
Study 2011, which was published last week in London, that the current focus of policymakers on short-term
results suggests that markets and economies are likely
to continue to exhibit a high degree of volatility,
reminiscent more of the 1970s and 2000s than the 1980s
or 1990s. The recent impact of rapid commodity
price rises on inflation is covered in the study, which
makes the case that the disinflationary impact of low
cost producers such as China and India is transitioning
into an inflationary influence. As a result, the global disinflationary trend of the past 30 or so years appears
to be turning.

Investment returns in the last decade were the
worst since the 1970s with real returns from equities a near-negligible 0.6%
annually in the period.

Holding cash delivered almost twice as much,
1.1% a year, while government bonds or gilts produced
return of 2.4% a
year.

Since World War II, only in the 1970s were
inflation-adjusted returns worse, at an annualised 0.4%.

The study says current policy settings are
extraordinarily easy and, if left in place for too long,
will result in destabilizing imbalances and stretched
asset valuations.

Piero Ghezzi, head of research in Economics and
Emerging markets at Barclays Capital and co-author of
the study, said last week that there has always been a
higher growth in emerging markets than in developed
markets but what has changed is the volatility in these
markets driven by high inflationary policies. With
equity returns in emerging markets likely to outperform
those of developed markets, he said that emerging
markets economies are maintaining policies too loose for
their cyclical position.

Amrita Sen, head of Commodities research at Barclays
Capital said the shift in the balance of economic power
underlines the resurgence of a historic shift in wealth
creation from West to East, bringing profound changes to
the economic and financial landscape.

“The higher demand for investment in emerging markets
themes is heavily reliant on commodities,” said Sen.
She expects resource scarcity would continue to be
a dominant theme in the future while the disinflationary
impact of low cost producers such as China and India is
transitioning into an inflationary influence. The sharp
rise in the prices of raw materials which, along with
other factors, suggest that the “30-year trend of
disinflation is ending.”

“The Equity Gilt Study offers a unique opportunity
for in-depth analysis of medium-term issues confronting
investors,” said Larry Kantor, head of research at
Barclays Capital. “The extraordinarily easy policies
put in place during the crisis are providing a
significant lift to financial markets, but at the same
time they signal important risks beyond the near term. In the meantime, investors should continue to
focus more attention on selected emerging markets, where
risk-return trade-offs are likely to continue to be more
attractive than for developed markets.”

Major themes of the Barclays Equity Gilt Study 2011
include:

There are significant risks associated with
leaving extremely expansionary policies in place for
too long;

Emerging market economies are set to continue to
deliver higher growth and lower volatility than
developed markets, which should translate into
outperformance in emerging market equities. Emerging
market debt, by contrast, has been largely
re-priced, and excess returns are likely to be much
smaller over the next decade;

The impressive growth of China and India is
increasing demand for commodities at a rapid pace,
making it difficult for technological advances to
allow production to catch up with demand;

Optimizing investment strategies for a more
volatile investment climate;

Ageing populations will reduce both stock and
bond returns over time, but the excess return on
equities is not as large as previously thought.

£100 invested in shares in 1990 with income reinvested
would be worth an inflation adjusted £323 today,
compared with an investment in gilts which would have produced
£311 over the same period.

However, since 1899, shares have produced a real annual
return of 5.1%, compared with 1.2% for gilts.

Source: Barclays Capital Equity
Gilt Study 2010 (Note: Where data is not available,
there is a gap).

Chapter 1 - Easy policies
today, rude awakening tomorrowExtraordinarily
expansionary policies played a
critical role in pulling the world
out of the financial crisis and
severe recession of 2008-09.
However, there are significant risks
associated with leaving extremely
expansionary policies in place for
too long. Such policies, if not
removed, are likely to cause
significant economic imbalances and
asset mispricing, making markets
excessively vulnerable to damaging
corrections and leaving economies
with limited ability to cope with
future shocks. This would not be the
first time that policy has been too
easy: in the 1970s, and again in the
past decade, easy monetary policies
left in place for too long led first
to market instability and then to
economic volatility. This time, the
situation is exacerbated by
overextended fiscal policies.

Chapter 2 - Navigating
the new EM landscape: Where to find
the best returnsIn the six years since this
series last took up emerging
markets, much has changed. Global
influence has moved from the
slow-growing G7 to booming China,
contributing to EM growth
outperformance. EM also weathered
the 2008 credit crisis remarkably
well, despite some initial
scepticism, due predominantly to
robust policy frameworks tempered in
earlier booms and busts. We think
investors should expect EM economies
to deliver higher growth and lower
volatility than in the past,
improving economic Sharpe ratios
relative to the lagging G4. Although
EM growth outperformance is part of
the received market wisdom, we think
it is not fully priced in to today’s
equity markets. We forecast EM
equity market returns of more than
10% (in USD, adjusted for US
inflation), in line with the past
decade’s strong performance.

Chapter 3 - A return to
scarcity: The disinflation trend is
overOver the past decades,
globalization has brought sleeping
giants to the global goods and labor
market. This, coupled with
technological advances in commodity
production, helped generate
disinflationary pressures globally.
However, the impressive growth of
China and India is increasing demand
for commodities at a rapid pace,
making it difficult for
technological advances to allow
production to catch up with demand.
This is creating inflationary
pressures on commodity prices,
making them more vulnerable to
shocks and, hence, more volatile. In
turn, policymakers face deeper
challenges, as central banks of
commodity-importing countries have
to fight these imported inflationary
pressures and respond to more
volatile price fluctuations.

Chapter 4 - Simple
strategies for extraordinary timesThe past decade has been a
rollercoaster ride for investors. In
the past 12 months alone, investors
have been buffeted by deficit
concerns in Europe, deflationary
fears in the US, and, most recently,
expectations of rising inflationary
pressures. Furthermore, the response
from policymakers has been
unprecedented, with central banks
embarking on a mission to ease
monetary policy via quantitative
easing and governments under
pressure to tighten fiscal policy
and tackle growing deficits once and
for all. We present simple
strategies to help navigate the
volatile waters of today's
investment environment: by extending
the humble diversification process
and focusing on risk- rather than
return-based allocation strategies,
we believe investors can protect
portfolio returns without worrying
about forecasting future returns or
timing the next big correction.

Chapter 5 - Dismal
demographics and asset returns
revisitedThe 2005 edition of the
Equity Gilt Study contended that
demographics are a powerful driver
of medium- to long-term trends in
bond and equity markets. In this
edition, we reexamine the issue of
demographics and asset returns more
formally in order to address
criticisms of past attempts at
quantifying potential linkages
between them. We find that
demographics matter, though perhaps
not quite as much as our earlier
work had suggested. Accordingly, our
original findings that demographics
would reduce both stock and bond
returns over the medium- to
long-term remain unchanged, and we
still expect equities to outperform
bonds over the next decade. However,
we now conclude that the equity risk
premium may be 1% lower than the
historical average, whereas we
formerly reckoned that it would be
1% higher.

Chapter 6 - UK asset
returns since 1899This chapter presents the
real returns of the major asset
classes in the UK. Financial markets
faced a volatile year in 2010, yet
equities managed to end the year in
positive territory. The FTSE all
share price index had fallen 12%
year-to-date by July, but managed to
rally 23% for the remainder of the
year. Equities were the worst
performing asset over the decade,
producing a meagre
inflation-adjusted return of just
0.6%, although this is a marginal
improvement over the negative
10-year returns produced over the
past two years. Gilts continued to
outperform equities over the 10-year
horizon and the annual performance
in 2010 was a marked improvement
from the negative returns during
2009.

Chapter 7 - US asset
returnsThis is the 11th year in
which we have incorporated US asset
return data. US asset returns
followed a similar trend to those of
the UK. Equities were the best
performing asset, despite periods of
intense volatility. US equities
followed European stocks lower as
the sovereign debt crisis unravelled
in the spring. The turbulence
continued into the summer as weaker
domestic economic data triggered
fears of a deflationary spiral back
into recession. Treasuries and TIPS
performed well, as the
flight-to-quality trend dominated
during the spring and summer months.
The Fed’s announcement of a second
round of quantitative easing helped
fuel a recovery in global equities
into year-end. Over the decade,
equities underperformed all assets
aside from cash.

Chapter 8 - Barclays
indicesWe have calculated three
indices: changes in the capital
value of each asset class; changes
to income from these investments;
and a combined measure of the
overall return, on the assumption
that all income is reinvested.

Chapter 9 - Total
investment returnsOur final chapter presents
a series of tables showing the
performance of equity and
fixedinterest investments over any
period of years since December 1899.

Pull outsThe final pullout section
provides the annual real rate of
return on both UK and US equities
and bonds (with reinvestment of
income for each year since 1899 for
the UK, and 1925 for the US). There
is also a table showing the real
capital value of equities for the
UK. Source for all data in this
chapter are the Barclays indices as
outlined in chapter 8.